“Valuation is both an art and a science,” Atelier Advisors’ Lili Balfour explains.
The science being the simple part: evaluating similar company valuations and creating a revenue or EBITDA multiple. The art, on the other hand, is more subjective. What is the team’s strength? What is the likelihood of the leads in the pipeline? How cutting-edge is the technology? – determines the worth of a startup.
How valuation is done for startups?
First, let’s go through the fundamentals.
What is the definition of startup valuation and are there startup valuation metrics?
The process of determining the worth of a startup company is known as startup valuation.
For mature, publicly traded companies with consistent revenues and earnings, valuation is done as follows:
EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization
However, setting startup valuation metrics is particularly challenging owing to the lack of key factors such as profit details, taxes, and amortization.
In this article, we’ll go through five ways for valuing your startup and preparing for future fundraising conversations.
5 popular startup valuation methods
Always keep some useful resources handy before proceeding with a startup valuation.
- Financial Statements
- Assess each team member skills and experience
- Prototype
- User Database/growth rate/effectiveness in marketing
1. Cost-to-Duplicate
As the name indicates, this process requires determining how much it would cost to construct a similar company from the ground up. The theory is that a wise investor would not pay more than it would cost to copy something. This method frequently looks at tangible assets to assess their fair market worth.
For example, the cost of replicating a software company may be calculated as the entire cost of programming hours spent creating its software. It might be the costs of R&D, intellectual property protection, and prototype creation for a high-tech startup. Since it is fairly objective, the cost-to-duplicate method is frequently used as a starting point for evaluating businesses. It is, after all, based on historical spending data that can be verified.
2. Discounted Cash Flow (DCF)
Discounted cash flow analysis is yet another alternative method among several startup valuation methods. For most budding organizations, especially those that have yet to generate revenue, the vast bulk of the value is based on future potential.
Financial analysts, venture capital companies, and angel investors use valuation methodologies to assess the worth of a business by projecting future cash flows and discounting them at a given discount rate to arrive at the present value. The resultant valuation for the startup will be the total of these discounted cash flows.
Forecasting sales and profitability beyond a few years is frequently a guessing game. Furthermore, the value provided by DCF models is heavily reliant on the discounted cash flow rate of return. As a result, attention should be exercised when using DCF.
3. Market Multiple
Software firms develop extremely quickly and spend all of their funds to grow even quicker, resulting in very little, if any, profit. Hence when founders in the software environment want to know how to value a startup with revenue, the best method is the startup valuation multiples method wherein you multiply your startup’s sales by multiple to arrive at a valuation.
The multiple is dependent on the startup’s growth rate and is agreed upon between the partners. A business expanding at 40% per year may get a multiple of 6 to 10, but a firm growing at 10% might only get a multiple of 1 or 2. In these calculations, rapid growth may dramatically boost the worth of your business!
Coffeemug.ai provides an ideal platform for start-ups and investors to explore expansion potential by connecting them with seasoned mentors who can explain how valuation is done for startups?
4. Scorecard Valuation Method
To begin, you must first determine the average pre-money worth of comparable businesses.
- The team’s strength ranges from 0 to 30%.
- The size of the opportunity is between 0 and 25%.
- 0-15 percent for a product or service
- 0-10% of the time, there is a competitive atmosphere.
- 0-10% marketing, sales channels, and partnerships
- Additional investment required: 0-5 percent
- 0-5 percent others
After that, you’ll assign a comparative percentage to each characteristic. When compared to your competition, you might be on par (100 percent), below average (100 percent), or above average (>100 percent) for each characteristic. Calculate the total of all elements for each startup quality. Multiply that amount by the usual valuation in your sector to arrive at your pre-revenue valuation.
5. Book Value Method
To get an asset-based valuation use the Book Value method. Its approach is the same as Cost-to-Duplicate; however, the procedure is quite simpler. In this strategy in order to arrive at an asset-based assessment, all outstanding obligations or liabilities will be deducted from the total assets.
Bringing it all together
So, there you have it: a roundup of the top startup valuation strategies. It is exceedingly difficult to assess a company’s truly worthwhile it is still in its early phases, as its success or failure is unknown. Valuing a firm is regarded to be more of an art than a science. The techniques we’ve seen above, on the other hand, assist to make the art a bit more scientific.
What Can Coffeemug offer?
Coffeemug’s artificial intelligence (AI) technology employs networking to allow users to interact and debate startup valuation ideas. Our platform allows you to attend meetings with industry professionals who will advise you on the best techniques and procedures for valuing your firm.
FAQs
Q. How do startups raise their worth?
A. Here’s how to raise the value of your startup
- A successful exit in the past.
- Carefully choose your team….
- Consider how you define milestones.
- Reduce your burn rate.
- Negotiate the terms of your fundraising.
Q. Why are venture capital valuations so high?
A. When the availability of venture capital expands, investors must compete with one another, and founders’ bargaining power grows, generally resulting in higher values.
Q. When a startup is overvalued, what happens?
A. The most significant risk faced by founders and earlier round investors as a result of startup overvaluation is a drop in value in subsequent rounds, making it difficult to attract funding.
Q. What is the definition of exit valuation?
A. The Exit Value (EV), also known as the Terminal Value, is the estimated price at which the firm will be sold. This is normally computed as a multiple of the company’s sales in the year of sale under the Venture Capital approach. This can be difficult for private enterprises, particularly startups.
Q. When should you sell your business?
A. When you have choices, it’s the greatest moment to sell your business. These choices don’t have to be acquisition bids; they may alternatively be term sheets for your next round of funding.
